Turkey’s banking sector has proved resilient to both the global economic crisis and more recent fluctuations in the country’s economy. Loan growth remains fairly high by developed-market standards but has trimmed in recent years, reflecting the market’s increasing maturity as well as regulatory moves to contain credit expansion with an eye on risk profiles.
In the medium to long term, the market should benefit from the large population, the scope for growth in a country with moderate levels of banking penetration, and the expansion of a diversified economy. However, recent events have shown that risks exist from foreign currency exposure, concentration risk in the construction sector, and the impact of economic and political events on the incomes of corporate and household borrowers.
Taking the Pulse
In February 2015, Deloitte, the global professional services company, issued a report which highlighted the industry’s strong growth over the past few years, and the opportunities for future expansion. Between 2007 and 2014, Turkey’s financial assets as a proportion of GDP rose from 146% to 202%, according to Deloitte, which noted a forecast rise to 247% by 2018. Despite rapid growth, financial assets remain well below global averages and even those for “economies in transition”: 813% and 242%, respectively in 2014, forecast to rise to 854% and 320%, respectively, in 2018.
Turkey’s private sector loans-to-GDP ratio jumped from just 33% in 2007 to 54% in 2014, although it is still less than half the global average of 115%. Loan growth in US dollar terms grew at a compound annual growth rate of 12% between 2007 and 2014, and is expected to clock up a similar rate up to 2018, with the ratio of private sector loans to GDP forecast to reach 66% in 2018. This compares favourably to a global average of 6% and a G7 rate of 2%, and is slightly above the average for economies in transition (11%). Meanwhile, deposit growth is forecast to pick up from 6% in 2007-14 to 11% in 2014-18.
As the market has matured, and competition on an already competitive market intensified, the net interest margin has narrowed, from 4.5% in 2007 to 3.2% in 2014. Further compression is likely, to 2.8% in 2018, just below the economies in transition average of 2.9% but still above the global level of 1.6%.
The message is that the sector has had a period of strong growth and will maintain positive forward momentum, while stabilising and moving towards global norms. In the long term the scope for growth is excellent, even in a competitive environment.
In the early months of 2015 the sector’s performance picked up, despite concern over Turkey’s political future with an election looming, and the weakening of the lira.
Assets in lira increased by 4% to the end of February from the end of 2014, while net profit jumped 8.6% from February 2014, with the sector as a whole posting net profits of TL3.46bn (€1.22bn). Loan growth in the first two months of the year was 3.8%, reaching a total of TL1.29trn (€453bn).
However, in US dollar terms, assets fell due to the decline in the lira. In April 2015 Intesa Sanpaolo’s executive vice-chairman, Marcello Sala, announcing his bank’s launch in Turkey, said that the four main risks to the system are high levels of private debt, the current account deficit, the lira’s depreciation against the US dollar and high inflation.
Strengths & Weaknesses
The IMF issued a detailed staff report on Turkey in December 2014 as part of its “Article IV consultation” with the country. Under the fund’s Article IV, the IMF holds bilateral consultations with its members, usually once a year, with its representatives meeting a range of officials, including those from the government and from the Central Bank of Turkey (TCMB).
The report highlights the sector’s strengths and weaknesses, noting its relative current stability, but also the considerable risks that could arise, as well as suggesting means by which the authorities could enhance the system’s operations and improve its insulation from these risks.
As the report noted, Turkey’s banks are fairly well-capitalised, with non-performing loans (NPLs) relatively low, at just 2.8%. The fall in the lira and rising interest rates had not, at the time of the IMF’s consultations, substantially increased the NPL ratio. Loan growth has helped offset a rise in bad assets, keeping the NPL ratio in check.
Banks have been able to pass interest rate hikes on to borrowers, maintaining the net interest margin at around 2%. Some analysts had expected a tightening of margins, but this did not occur. Banks’ on balance sheet short FX position also bolstered margins in the wake of the lira’s fall. However, the rising rates (as well as factors such as lower economic growth and a higher risk perception) did trim credit growth somewhat, putting downward pressure on return on equity, which stood at 126%.
Banks’ buffers to shocks remain ample, with capital adequacy standing at 16%, well above the minimum demanded by regulators, and most capital is Tier 1. Liquidity adequacy ratios (at maturities of one week or one month total or foreign currency only) are also ample, with liquid assets covering more than 100% of short-term liabilities – and this despite rather conservative assumptions on the proportion of deposits that are vulnerable to capital flight. Stress tests have also shown that the system is well prepared for even significant shocks.
One of the biggest risks to the banking sector – and to the Turkish economy as a whole – is over-reliance on foreign exchange financing. In recent years, banks have relied on cheap wholesale financing to fund lira-denominated loans. Given the lira’s historic vulnerability and its recent depreciation, this has become a concern for the sector and the authorities overseeing it.
At the end of 2014 the sector had an overall loan-to-deposit (LTD) ratio of 114%. In other emerging markets, including in Turkey’s neighbours in Central and Eastern Europe, with which the country is sometimes bracketed by financial institutions, there have been efforts to reduce the LTD to 100% or below in the wake of the global financial crisis. There is a sense that banks need to rely more on deposits to finance loans, in order to reduce risk. Turkish banks’ foreign currency LTD ratio remains below that, at 84%, while local currency LTD is at 131%.
According to the IMF, wholesale external funding denominated in foreign currency is helping drive the expansion of lira-denominated lending. Naturally, this exposes banks to risk of their external obligations rising in value relative to the debt that they can call on from their own customers. According to the IMF, foreign exchange liabilities now outstrip deposits by TL397bn (€140bn), or 21% of total assets.
The fund says that foreign exchange exposure through this mechanism more than doubled to €103bn by early 2014, from €46bn in 2009. Banks are aware of the risk, and hedge it off balance sheet, so the sector’s net open foreign exchange position is only around 0.1% of GDP.
However, the IMF has warned that in the event of market sentiment turning negative, the rollover risk (refinancing risk) – and thus foreign exchange liquidity risk from gross forex exposure – is significant. The fund suggests that banks’ required reserve deposits with the central bank could be used to support foreign exchange liquidity.
Banks also have indirect exposure to exchange rate risk via foreign currency lending to non-financial corporates. These types of loans have increased more than three-fold in less than a decade, reaching some €114bn in July 2014, up from less than €30bn in 2008, partly as a result of tax and prudential policies that encouraged the shifting of foreign currency lending onshore.
Risk is somewhat mitigated by prudential regulations that restrict foreign currency lending, limiting them to those with export receipts, and those with better ability to hedge financially and access foreign currency denominated assets.
A recent TCMB study suggested that export receipts help hedge a net open position. However, the IMF calculates that around €20bn in foreign exchange-indexed loans is not covered by these prudential regulations, despite similar risks.
One blessing for the sector is that foreign currency lending to households is forbidden. This has helped prevent the soaring NPLs seen in parts of Central and Eastern Europe, where banks lent freely in euros and Swiss francs to households during the boom years of the last decade, only to see households unable to service the debt when the economy turned downwards and currencies fell in value. Hungary and Romania have been particularly affected.
Sector profitability as a whole has declined in recent years, dragged downwards largely by lower net interest income and less efficiency. Despite a doubling in loan volume and a 50% increase in equity since 2010, profits have scarcely risen, according to the IMF.
Between 2005 and 2010, return on average equity (ROAE) averaged 23% and return on average assets 3%, but these have now fallen to 13-15% and 1. 5-2%, respectively. Since 2010 ROAE has slipped by an average 9.5 percentage points, with approximately 80% of the reduction due to falling net interest income, and most of the remainder caused by a decline in net non-interest income.
Net interest income has fallen due to a drop in credit extended to the government, without a corresponding fall in interest expenses. Interest income dropped by 17.4 percentage points after a 1.8 percentage point fall in loan book profitability, but largely driven by a 13.5 percentage point fall in interest derived from securities after a decline in the proportion of government securities in banks’ portfolios. Government securities accounted for 38% of total assets in 2010, falling to 16% in 2014.
Falling profits and rising risk may catalyse consolidation, or at least efforts to improve efficiency in the sector. As the IMF notes, “over the medium term, banks will need to bring loan growth, equity and profits back into line, with a focus on enhancing margins”. Banks can boost efficiency by better pricing, cost efficiencies (which in some cases slipped during the years of strong growth, due to a lack of incentive), improved risk management and increasing revenues earned from fees.
The IMF has praised the TCMB for its efforts to slow consumer credit growth and improve its stress-testing procedures. In 2013 credit card limits were tightened and provisioning rates were increased, and in February 2014 the central bank tightened limits on instalment purchases. These measures caused a rapid deceleration in credit growth from 40% to 18% in the year to August 2014, based on an annualised 13-week moving average. “The heightened scrutiny for credit cards and consumer loans that the regulations introduced were needed, especially the strict rules for fees, loan sizes and settlement periods,” Cem Mengi, the former deputy CEO of ING Bank, told OBG.
The IMF noted that further macroprudiential measures to target banks’ wholesale foreign currency financing would be worthwhile, to trim foreign exchange leverage in the banking system. Measures it suggested included reducing inducements for the non-financial corporate sector to take on foreign currency risk, for example increasing capital charges or greater provisioning for foreign exchange loans to unhedged corporates, and matching the prudential regulation of foreign exchange-indexed lending with direct foreign exchange lending.
“Consideration should also be given to complementary non-price measures,” the fund said. “For instance, a ceiling on the use of derivatives for FX hedging purposes while keeping the current net open position limits, or on the non-core to core foreign exchange liabilities ratio would have the obvious impact of containing wholesale FX funding.”
The IMF said that these measures would indirectly affect domestic demand, but would not stand in place of a tighter macroeconomic strategy as a whole from the government. Furthermore, such measures would have to be implemented carefully, taking into account the extent to which banks can pass costs on to customers, whether creditors or debtors.
AML & CFT
In another area of regulation, Turkey has made significant progress: tackling money laundering and financing of terrorism. This is particularly significant for Turkey, which has historically had issues with corruption and has suffered from terrorist attacks, and has been seen as a conduit to the wars in the Middle East. In October 2014 Turkey was removed from the Financial Action Task Force list of countries with “strategic deficiencies” in their anti-money laundering and combating financing of terrorism frameworks, having made steps to tighten rules criminalising financing of terrorist organisations and setting up procedures to identify, freeze, and confiscate assets linked to terrorism.
As of the end of the third quarter of 2014 there were 46 banks in Turkey, with total assets of €604bn, employing close to 200,000 people. The market is dominated by seven institutions, though there are a range of other players as well as development banks, investment banks and banks focusing on specific market niches.
The biggest bank in terms of assets is the state-owned Ziraat Bank, established in 1863, with assets of €78.8bn as of the end of the third quarter of 2014. The other banks in the top five are all privately owned: İşbank, with assets of €76.4bn; Garanti Bank (€71.1bn); Akbank (€66.8bn); and YapıKredi (€55.8bn). They are followed by two state-owned banks, Halkbank (with assets totalling €49.6bn) and Vakif Bank (€48.7bn), two foreign-owned institutions – Finansbank (owned by the National Bank of Greece), with assets of €24.7bn; and DenizBank, acquired by Sberbank in 2012, with €23.2bn. Completing the top 10 is Ekonomi Bank, with assets of €20.3bn. Other major international banks present on the market include HSBC, Citibank, ING and RBS.
The major banks’ key performance figures differ considerably, reflecting differences in their management and strategies. As of the first quarter of 2014 – the last year for which figures were available at time of press – net interest margin ranged from 3.9% for Vakıfbank to 5.1% for Finansbank, according to a report by investment bank JP Morgan. Akbank stood at 4.4%, İşbank at 4.2%, Garanti at 4%, Halkbank at 4.6% and YapıKredi at 4.1%.
Garanti had the highest return on equity, at 15.3%, with Halkbank at 15.2%, İşbank at 12.8%, Akbank at 12.1%, Vakıfbank at 10.9%, YapıKredi at 9.4% and Finansbank with 7.1%. Loan impairment charges as a proportion of average loans varied from 2% for Finansbank to 0.9% for Halkbank.
Despite the variations in performance, in its report JP Morgan said that it continued to see Turkey’s biggest systemic banks as a “generally homogenous asset class, with the broadly similar credit metrics and the same assumptions of systemic importance”. However, it did highlight potentially slightly weaker performance from Finansbank and YapıKredi due to their stronger focus on consumer lending. Consumer confidence has dipped in late 2014 and early 2015 due to lower economic growth, rising inflation and a new degree of political uncertainty.
Coming & Going
Thanks to its size and growth potential, the Turkish banking market continues to attract international institutions looking to establish or expand their presence in the country. This is despite the cooling of market sentiment and the growing appreciation of risks from loan growth, the depreciating lira, and the slowing economy – indeed, for some investors, this is the time to capitalise on more attractive capital values.
In November 2014, Spain’s Banco Bilbao Vizcaya Argentaria (BBVA) raised its stake in Garanti from 24.9% to 40% for an additional €2bn, giving it control of the bank’s board, with seven of 10 members. BBVA had acquired its stake in Garanti for €4.4bn in 2011, with a view to expanding its holding and taking board control in 2016; in the end, it moved earlier to capitalise on market conditions.
Jaime Saénz de Tejada, BBVA’s chief financial officer, told the press that his bank had achieved a “very good price”, and expressed confidence in long-term growth. The Spanish lender brings its expertise in mortgage lending and small and medium enterprise (SME) finance in particular to Turkey – two currently under-banked segments. “Many Turkish banks are looking into ways to increase services to SMEs,” Ümit Leblebici, general manager at TEB, told OBG. “Given their large share of total companies and relatively limited use of financial services, they offer a huge opportunity to banks that are willing to become their partners and to help them grow”.
SME lending is also an area of focus for Italian bank Intesa Sanpaolo, which in April 2015 announced plans to expand further in Turkey, having opened a branch in Istanbul in June 2014. Intesa will also look to serve the 1200 or more Italian-owned companies present in Turkey, as well as new entrants from its home country, bank officials said.
The BBVA and Intesa announcements followed one of the biggest deals in recent years, the €2.92bn acquisition of a 99.85% stake in DenizBank by Russia’s state-owned Sberbank from Belgium’s Dexia in June 2012. The deal reflects both growing interest in Turkey from emerging market banks, and the reality of exits by Western institutions under pressure after the financial crisis. Dexia’s sale was forced by the French and Belgian governments as part of a restructuring plan, and it achieved only 1.33 times Garanti’s book value, having made the acquisition at a ratio of 4.62 times book value.
Both HSBC and Citigroup, two major international institutions, have also announced plans to downsize in or exit the Turkish market, with HSBC looking to shed its retail division, which has 300 branches and assets of around €3bn.
International ratings agencies keep a close eye on the sector, and ratings movements can affect the borrowing costs of Turkish financial institutions. With Turkish banks having taken on substantial foreign debt, ratings can be a gauge of the borrowing costs they are set to bear. In April 2015 Moody’s Investors Service said it would be maintaining a negative outlook for Turkey, and a Baa3 rating, with lower economic growth and currency volatility drivers behind its decision, and that both would lead to the continuation of a negative outlook for the banking sector. Fitch reached similar conclusions.
Pressure on the TCMB from President Recep Tayyip Erdoğan also had an impact on the ratings, calling into question the bank’s independence from political interference and shaking economic confidence. With parliamentary elections due in June 2015, Erdoğan has been keen to boost flagging growth, while the TCMB has tried to stick to its official mandate of price control, trimming rising inflation. In early 2015 senior government representatives mounted a campaign to convince investors that the central bank remains independent (see analysis).
As of mid-2015, a consensus has formed on the Turkish banking sector: it is secure, has a positive growth outlook, and is well-capitalised enough to deal with rising risks from foreign exchange exposure and investor sentiment. However, these risks should not be discounted, and further depreciation of the lira could make the going tougher for exposed banks. The environment is already more difficult, as economic growth has fallen, inflation has risen and political uncertainty has emerged. In this context, moves in 2013 to trim loan growth seem prescient.
Despite a more becalmed market in 2015, the outlook for the longer term is still very positive. “The demographics offer considerable opportunities for banks looking to enter the market. Where else can a new player service more than 100,000 customers in its first year?”, Hüseyin Özkaya, a board member and general manager at Odeabank, told OBG. Turkey has one of the world’s largest emerging economies, a large and growing population, and a diversified economic base. The continued entry of new players to the market is indicative of the sector’s potential.